Portfolio managers hoping to buy the Sep/Oct dip were caught by surprise when there was no dip.

This has been a year of surprises. The indexes spiked after the election and for months analysts kept waiting on a post election decline. Despite several minor dips along the way, with the largest only 3.2% on the S&P, the index has rallied 23.5% since the November 4th close at 2,085. Everything that has happened in 2017 has been a surprise. None of the seasonal trends appeared and the market kept ignoring multiple events that should have caused deeper corrections.

Now portfolio managers are trapped. If they were holding cash in hopes for a dip, they are under performing the market. They have to hold their nose and buy stocks ahead of the "normal" Q4 rally, which typically starts after October option expiration. November 1st is historically the start of the best six months of the year.

Cash is trash today in terms of portfolio performance. They have to buy something. So far, they are not buying big cap tech stocks. Nearly all of the big tech stocks have choppy charts where investors have been rotating out of those positions and into materials, industrials, defense and small caps.

There is an actual rally in progress. We have to ignore the Dow because of its limited 30 stock, price-weighted construction. As we have seen in recent weeks only five stocks (BA, CAT, HD, MMM, UNH) contributed 500 of the last 1,000 Dow points. That is not a market. It is a simple indicator of investor sentiment.

The Dow is grossly overbought and over extended but as we know from past experience, stocks and indexes can remain irrational far longer than we can remain liquid if we are betting against them. The Dow will eventually see some profit taking and the talking heads on stock TV will wring their hands and ask stupid questions to analysts to fill airtime with a reason for the sudden decline. Ignore it.

The economy is fine. Jobs are fine. Earnings are expected to show double-digit growth for the next three quarters. The global economy is expanding. Tax reform is coming. As long as North Korea does not explode a nuke over the Pacific the market should continue its rally. There will be pauses but over the next six weeks, every pause should be bought.

Why are portfolio managers in a panic and chasing prices? They are taught some level of technical analysis early in their career along with fundamental analysis. They are taught to buy dips. They do not buy tops because over the long term the dip buys are always more profitable. Many managers have simple systems. They almost always default to moving averages.

It is hard to go wrong picking a moving average that is clear support on whichever stock or ETF you want to buy and then wait for that average to be tested. A 50-day average is common along with the 100-day and 200-day. The longer averages require more patience. Unfortunately, every stock/ETF reacts differently to every average. Managers have to find the one that works for that stock and then wait. A 7-year old could do it. Unfortunately, it requires patience and this year, patience and the calendar have not been evenly matched.

For instance, in the QQQ chart below, the 50-day average (green) does not work. It is penetrated to often and that causes nervous nights at fund headquarters. An astute manager could have played with the numbers and saw that the 75-day works perfectly for the QQQ over the last year. You wait for the dip to the 75-day and enter the position. On the QQQ, everything worked perfectly. There was a dip in late September exactly when it should have dipped and the ETF is now at new highs.

So let's see how that would have worked on the S&P. Using the same 50-day average there was a test in August that would have been a great entry point but managers were expecting the volatility to continue into September since Aug/Sep are the two most volatile months of the year. The S&P rebounded and did not come back to the average since that August dip. The S&P is up 150 points since that late August low and managers who did not buy the dip in August have been sitting on the sidelines watching the market run away from them. As a portfolio manager, that is a very frustrating experience.

Now, knowing what you know, would you buy this chart on Monday morning? I seriously doubt it. You can wait because your job and your performance bonus is not riding on your gains over the next two months. You can be patient, while fund managers at the end of October, no longer have that luxury.

On a side note look at the CCI indicator on the bottom. Notice how clear the signals are? Green equals buy, red equals sell. The MACD is even better. Sell when the blue line crosses down over the red and buy when it crosses back higher. The MACD gives earlier signals but it has a little more noise. Use them both together. Note the MACD at the far right where a negative cross appears imminent.

Our reality check on the S&P is still the A/D chart which closed at a new high on Friday. There is no weakness in the internals despite the small gains in the index early in the week.

The Dow is so overbought there is nothing I can say positive. Nobody in their right mind would buy this chart but the key is that they are not buying the chart but 2-3 Dow stocks based on headlines. Nearly every day the advancers and decliners are almost even but there are 2-3 outperformers that rescue the index. There are 12 Dow stocks reporting this week and once that is over the post earnings depression period will appear.

The 50-day average is normally used to track the Dow but nobody actually trades the Dow. There is an ETF (DIA) but it only traded 3 million shares on Friday when the Dow was exploding higher.

I only have one question. Does anyone believe the Dow will not retest the 50-day average in the coming months? Obviously, everyone should expect it regardless of how bullish your bias.

The Nasdaq chart looks a lot like the beginning of a rounding top. If the index falls back below 6,600 again, I think it could trigger a bigger decline. If you look at the three times on the chart where the index went nearly vertical for several weeks it always ends suddenly. Two of the three times is took a month for the index to recover. I am not predicting that over the next several weeks but there are plenty of big earnings events that could spoil sentiment for the tech sector. I would love to see a couple hundred more points but we have to be realistic and expect patterns to repeat. Note the MACD on the far right.

The Russell moved sideways for so long the moving average is not working. The index is still overbought but it did work off a lot of the pressures with the decline over the last two weeks. I am in "show me" mode here. A move over 1,520 is a bullish breakout and a close under 1,500 again is a danger signal. Note the MACD crossover.

I believe the market will continue to move higher over the next month but not necessarily in a straight line. There are overbought pressures to be equalized and that can happen by consolidating in place for a week or two or a sharp 2-3 day decline and rebound. The consolidation is less painful but does not provide clear buying opportunities. With fund cash positions still high, every dip should be bought.

The trend is our friend until it ends but there is rarely any warning.

Enter passively and exit aggressively!

Jim Brown

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